Does Majestic Gold (CVE:MJS) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Majestic Gold Corp. (CVE:MJS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Majestic Gold

What Is Majestic Gold's Debt?

The image below, which you can click on for greater detail, shows that Majestic Gold had debt of US$7.36m at the end of September 2020, a reduction from US$14.0m over a year. But on the other hand it also has US$19.5m in cash, leading to a US$12.1m net cash position.

A Look At Majestic Gold's Liabilities

The latest balance sheet data shows that Majestic Gold had liabilities of US$28.0m due within a year, and liabilities of US$4.50m falling due after that. Offsetting this, it had US$19.5m in cash and US$20.5k in receivables that were due within 12 months. So its liabilities total US$13.0m more than the combination of its cash and short-term receivables.

Majestic Gold has a market capitalization of US$41.1m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Majestic Gold boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Majestic Gold has boosted its EBIT by 90%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Majestic Gold's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Majestic Gold has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Majestic Gold created free cash flow amounting to 8.9% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

Although Majestic Gold's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$12.1m. And we liked the look of last year's 90% year-on-year EBIT growth. So we don't have any problem with Majestic Gold's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Majestic Gold .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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